Sta. Ana coordinates Action for Economic ReformsThis piece was published in the May 31, 2010 edition of the BusinessWorld, pages S1/4 to S1/5.

One of the critical binding constraints that the incoming Noynoy Aquino administration will face is the low tax effort.  Tax effort, described as the amount of taxes collected as a percentage of Gross Domestic Product, has been dismally low during the Gloria Macapagal-Arroyo regime.  In 2009, the tax effort was just 12.65 percent, far from the desirable 17 percent that was reached before the economy plummeted in the wake of the 1997 financial crisis.

What is ironic is that the tax effort has stagnated and even declined despite the fact that the Macapagal-Arroyo administration increased the excise taxes on sin products and jacked up the rate of the value-added tax (VAT) from 10 percent to 12 percent.

The increase in said taxes, among other things, was a forced move on the part of the Macapagal-Arroyo administration to avert a looming fiscal crisis after the highly controversial elections in 2004. The fiscal crisis was manifested in declining tax effort, increasing debt and debt-service ratios, and a yawning public sector deficit.  It was triggered by overspending, unsustainable populist measures, huge losses incurred by government corporations, and non-implementation of tax reforms—all intended to favor political allies and vested interests as well as placate or woo voters.

However, the gains from the increase in the excise taxes on sin products, the VAT, and the increase in power tariff diminished as complacency set in. In particular, key reforms like inflation indexing of the specific tax on sin products, the rationalization of fiscal incentives, and the simplification of the net income taxation for the professionals and self-employed have stalled.  Moreover, Macapagal-Arroyo and her Congress allowed the passage of revenue-eroding measures.

A compounding factor is the recent announcement to remove the three percent tariff on imported oil products. At this point, any action that takes away revenues hurts the economy.

On tax administration, the momentum for reforms petered out after the principled resignation of Guillermo Parayno, a competent and credible reformer. Worse, the creation of redundant bodies, namely, the Presidential Adviser on Revenue Enhancement (PARE) and the Presidential Anti-Smuggling Group (PASG) undercut the Bureau of Internal Revenue (BIR) and the Bureau of Customs (BOC). PARE and PASG merely heightened uncertainty among businessmen and opened new sources of corruption.

All told, without any decisive intervention, another fiscal crisis is bound to happen.  The fiscal problem has actually become a binding constraint, hindering spending for essential services like infrastructure, education and health as well as threatening macroeconomic stability.

But the advent of a new, credible, and reformist Aquino administration is the first necessary step to prevent the crisis from erupting.  President Noynoy Aquino enjoys much goodwill and political capital that he can put to good use to advance hard reforms.

The President-elect has said that he will focus on the efficiency of tax administration to increase revenues.  We can indeed expect a revenue boost, precisely because he has the moral ascendancy and the people’s trust to enjoin taxpayers to cooperate.

Part of the tax administration reforms is the abolition of redundant revenue-collecting bodies.  This will receive wide public support. The new administration can also benefit from the BIR’s modest efficiency gains in recent months.

Supplementing the tax administration reforms is support for the tax policy proposals sponsored mainly by the Department of Finance. The package consists of the following: a) the indexation of sin products to inflation, b) the rationalization of fiscal incentives, and c) the simplified net income taxation for the professionals and self-employed. Sadly, these measures received unenthusiastic support from Mrs. Arroyo.

Some might argue that the President-elect made a promise not to impose new taxes.  But the president-elect also qualified that statement.  In the event that the tax administration reforms would be insufficient to meet revenue goals, he would be open to introducing new measures.  But more importantly, to paraphrase the World Bank’s Country Director Bert Hofman, an adjustment of the specific taxes to inflation is not really a new tax.

For the medium term, we should welcome green taxes.  Green taxes or pollution taxes will be our contribution to the global effort to address climate change.  Green taxes offer a triple dividend—a healthy fiscal balance to ensure macroeconomic stability, revenues for development spending, and a cleaner environment.

We are optimistic that fiscal reforms will prosper under the incoming administration, given that our people will recover their trust in government.  A leadership not tainted with corruption—a decent and honest leadership—is the key to the success not only of the fiscal agenda but of the over-all reform program to reduce poverty, create jobs, and sustain growth.